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Saturday, November 13, 2010

As an independent analyst and moderator of the Apple Finance Board I'm posting preliminary FQ1 estimates for Apple as a catalyst for discussion of anticipated December quarter results. These estimates are subject to change and most likely will be revised in the coming weeks as we approach the end of the quarter. These estimates are being published at roughly the half-way point in the 13-week fiscal period.

FQ1 Revenue and Earnings Estimates

For the December quarter my current models forecast revenue of $26.221 billion and earnings per share of $5.80. This represents an expected 67% jump in revenue and a 58% rise in earnings per share.

The pace of eps growth trails revenue growth due to the estimated 37% gross margin this December versus the 40.9% gross margin in the prior-year period. This nearly 400 basis point drop in the gross margin ratio has a material impact on the relationship between revenue and earnings growth.

Apple has become more aggressive on product pricing relative to build costs. It's my view the moderation in gross margins is intended to promote growth in after-purchase revenue from the sales of apps and content. The more units sold the more future revenue generated from units sold.

Apple's Dynamic Revenue Mix

Two weeks ago I posted an FY2010 retrospective that illustrated the percentage revenue contributions from each of Apple's major product lines. Apple's overall revenue mix remains dynamic and changes by the quarter. The emergence of the Apple iPad will again change the percentage of revenue contributions from each product line to Apple's reported results. In the December quarter I expect the Apple iPad's revenue contribution to approach 16% of reported revenue. Each revenue dollar from Apple iPad sales in the December quarter is a gained revenue dollar relative to prior-year comparisons. My estimates suggest the Apple iPad will represent more than 50% of the estimated growth in revenue for the period.

I currently forecast a 25% gain in Mac unit shipments versus the prior-year period. During fiscal year 2010 Mac unit sales grew 31%. I expect a slowing in the pace of global PC sales and for the Mac's unit sales growth performance to be more than double the pace unit sales growth for the industry.

iPhone Unit Sales

During fiscal year 2010 iPhone unit sales grew 91%. I expect the iPhone improve on that performance in the December period and to perhaps match the prior-year's December unit sales growth of 100%. For now I'm estimating about a 94.5% growth in unit sales this quarter.

iPod Unit Sales

The Apple iPod product line is in a phase of negative unit sales growth. I expect this trend to continue. However, the Apple iPod touch should continue to show unit sales gains while single-use or specific-use digital music players lose popularity in the global marketplace. For the December quarter I estimate a 12% unit sales decline.

iPad Unit Sales

If there's an Apple product line that's perplexing to forecast for revenue and unit sales outcomes it's the Apple iPad. The September quarter's 4.188 million unit sales performance was underwhelming for most analysts. For now I'm estimating 6.25 million units sold based in part on wide domestic distribution for the holiday season. However, this unit sales estimate is the one I expect to undergo the biggest revision between now and the end of the quarter.

Apple's Tax Rate

While much attention is paid to Apple's gross margins, far less attention is paid to the company's effective tax rate and its impact on earnings. Apple's tax rate over the past several quarters has moved south in a dramatic way. The most recent eight-quarter tax rate average is 28.1% versus 24.5% for the most recent four-quarter period. For the December quarter I'm forecasting a 24% tax rate versus management guidance of 25.5% for the quarter. As revenue scales significantly higher and gross margins continue to moderate, the tax rate has a material impact on earnings and earnings per share and significantly impacts each quarter's results.

Preliminary Conclusions

Due in large part to the emergence of the iPad, Apple will achieve revenue growth exceeding 60% in each quarter of the current fiscal year. In the December quarter the iPad's influence on the company's revenue and earnings performance will be even more pronounced due to the absence of iPad revenue activity in the prior-year period. My preliminary revenue estimate for the December quarter is north of $26 billion. I don't take this level of revenue activity lightly and my forecasting model is conservatively biased.

These estimates will undergo revisions over the remaining weeks of the December quarter. I'm posting preliminary numbers today as a catalyst for conversation and debate on Apple's expected December quarter revenue and earnings performance.

I believe your estimates for gross margin is low. The biggest impact to gross margin has been the currency exchange rates. This Q, the US dollar has depreciated considerably. Apple uses the exchange rate on the last day of the previous month as a basis for revenue purposes for the current month. Last Q averaged 1.2684 dollar to the euro. This Q it is averaging about 1.38 (oct - 1.3598 ( sept. 30 published rate), nov - 1.3945 (oct. 31 published rate)). Also accretive to gross margin is the end of the free bumper case.

Concerning the gross margin, there's more at play than exchange rates. Apple is purposely pricing product aggressively relative to build costs to gain market share. The iOS devices in the market create after-purchase revenue opportunities through the sales of books, apps and digital content. The more products in the hands of consumers the more revenue Apple can realize through iTunes sales activity.

I expect gross margins to remain high, but I expect moderation in gross margin goals to support revenue growth from digital content sales through iTunes.